By Paul-Martin Foss
We read in the Wall Street Journal that “Mom and Pop Buck Trend to Snap Up Physical Gold.” News flash: there is no such thing as non-physical gold. Gold is an element that is alloyed with other elements and minted into coins or melted into bars. If you can hold it in your hand, it’s gold. If you can’t, it’s not. And like most other goods, when the price of gold drops, demand to purchase it increases. No surprises there, except to those in the financial press who are confusing gold (“physical gold”) with gold funds and derivatives (“paper gold”). As Zerohedge pointed out the other day, there is a tremendous disconnect between the amount of gold available for delivery and the amount of gold “owned” by investors. Too many people treat physical gold and paper gold as equivalents.
It really isn’t any different than with cash. If you own a dollar bill ($1 Federal Reserve Note) you have a dollar. If you deposit that dollar bill into your bank account, you no longer own a dollar, you have a $1 deposit balance, a claim to a dollar. That is not the same thing as owning a dollar. There may be a 1:1 exchange ratio between dollar bills and bank deposits, meaning that you can go to your bank and reduce your bank account balance by $1 and receive a $1 bill in return. Buyers and sellers may treat bank deposit balances as functionally equivalent to cash for making purchases. But at the end of the day that $1 bill and that $1 bank account balance are not the same thing and that 1:1 ratio is not a given. It may hold 99% of the time, but when that 1% occurs and you can’t access that cash, or you have to take a haircut on your bank deposits, or you’re limited to $60 a day ATM withdrawals, or whatever crisis rears its head, that bank account balance isn’t going to do you a lot of good.
The same thing happens with gold, and you find this type of confusion all the time throughout the financial press. Financial markets may treat paper gold and physical gold as equivalents. Governments will tax paper gold the same way that they tax physical gold. But paper gold and physical gold are not the same thing. So let’s clarify things. If you own a gold coin or bar that you can hold in your hand, you own gold. If you own gold coins or bars that are stored somewhere else, you don’t own gold, you own a claim to gold. If you own shares in GLD or another gold-based exchange-traded fund (ETF), you don’t own gold, you own shares in a fund that claims to own gold and tie the value of its shares to the price of gold.
Putting gold in a safe deposit box or buying shares in a gold ETF as a protection for when the SHTF is like building bug-out bags and then packing them into a self-storage unit. You’ve probably heard the stories of Jews who fled Germany to Switzerland, hoping to withdraw money from their Swiss bank accounts, only to find out that the banks refused to give them their money. They thought they owned that money but found out the hard way that they didn’t. If you own gold and put it in a bank safe deposit box, good luck getting it out in the event of a bank crisis. If you own shares in GLD or a similar ETF, you’re not going to be able to take delivery of that gold. Gold is gold. Paper gold is a derivative. It derives its value from the underlying asset, gold, but it is not gold itself. For financial writers to talk about the decrease in the spot price of gold, which is largely driven by markets in paper gold, as though it reflects a decline in trust in gold is bogus. Maybe people who were just looking for a quick return are tired of paper gold, but there is no reduced trust in gold itself.
Nor is there a trend of dumping gold. You want to sell your shares of GLD, an ETF that won’t even let you take physical delivery of gold? That’s great, but you’re deluding yourself if you think you’re selling gold. Gold is like a lot of other assets in that, ceteris paribus, as the price decreases the demand increases. We’re living in crazy economic times, going on nearly seven years of near-zero interest rates and with some central banks pushing interest rates into negative territory. The 2007-08 financial crisis was the front of the hurricane and now we’re in the eye. Things may seem to be somewhat back to normal, but there’s a weird feeling. The economy is only barely humming along because of artificial stimulus introduced by central banks, which is why we’re still at zero interest rates with a so-called “recovered” economy. Employment is still middling and all the “good” economic data is constantly revised downwards after the fact. We’re in the eye of the hurricane and we know once the eye passes over us we’ll be whacked by the hurricane’s tail end. People realize that the coming crisis is likely going to be far worse than what we saw in 2008, which is why they’re rushing to scoop up gold while it’s cheap. So attitudes toward gold haven’t changed one bit, it’s still just as highly in demand as it’s ever been. The mom and pops buying up physical gold is the trend, the dumping of ETFs is not.
Another writer, Noah Smith, says “If you followed Austrians’ advice and bought gold at the peak, you have now lost more than a third of your money.” He couldn’t be any more wrong. Leaving aside the fact that most Austrians would not have bought at the peak, nor advised anyone else to do so, if you bought 20 ounces of gold, you still have 20 ounces of gold. It didn’t go anywhere. It might have lost a little bit of paper value, assuming you mark the value of your holdings to the spot price, which is not a realistic indicator of the market value of coins anyway. But let’s be honest, the reason people buy gold is not because they hope its nominal value will increase or that they can make a good return on it, it’s because gold is the ultimate hedge against the breakdown of the monetary system. When everything else fails, gold is still there to be used and accepted as money. That is its real utility. There’s a reason central banks hold gold and not diamonds, oil, or other assets. When fiat paper money fails, when government money and banking systems break down, gold is there to step into the breach, fulfilling the monetary role it has played for thousands of years.
This article was originally published at The Carl Menger Center